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Charles Anniss, manager of the £147m M&G European Smaller Companies fund, says he looks for companies with high earnings, exposed to structural growth trends, undervalued by the market.

Sound optimistic? Mr Anniss claims not. “The European small-cap universe is still littered with inefficiencies,” he says.

Mr Anniss, who holds a degree in French and Spanish, co-managed the fund with Giles Worthington from March 2006 to January 2007, when he became sole manager. Since January 2007, the fund has returned 6.7 per cent, compared with a sector mean of 0.12 per cent. This ranks it in the second quartile.

But Mr Anniss says since he learnt his craft from Mr Worthington, his graduation to sole manager was “evolution, not revolution” for the fund. In particular, he stresses his approach, like Mr Worthington’s, focuses on the long term.

“We’re not interested in next quarter’s earnings. Our turnover, according to the FSA definition of sales plus redemptions, is 60 per cent, which means our typical holding period is three years. That gives time for the inefficiencies to play out,” he explains.

A long-term approach can only be judged by long-term performance. The fund’s three-year track record places it seventh out of 14 funds. It grew 71.7 per cent over the period to 9 June, while the sector grew on average 67.8 per cent.

Mr Anniss’s singlemost important metric is profitability. He favours return on capital employed in particular as a measure of value creation. He screens for profitable companies capitalised at between €300m (£237.41m) and €3bn – a universe of 4000-5000 stocks in Europe – using a database programme called Holt.

But Mr Anniss also insists on the necessity of meeting management. “I’m off visiting companies two to three times a month. It’s very important meeting managers on their own turf. They’re so much more relaxed than when they do investor roadshows in London, which they find boring,” he says.

One company Mr Anniss has found by this method is the German industrial Gerresheimer, which traditionally made glass bottles and containers for the cosmetics and beverages industries, but has recently moved into more attractive niches such as syringe manufacture.

“Management has had an explicit mandate to invest heavily in high-growth businesses. Ready-to-sell syringes have been growing at 30-40 per cent,” he says. “What was a stodgy German industrial making bottles has transformed itself over the last five to 10 years into a medical technology company. Seventy-five per cent of its business is now derived from medical-related businesses.”

Mr Anniss also praises Gerresheimer’s EBIT margin of 20 per cent. “There are very high barriers to entry, as it’s hard for pharmaceutical companies to switch suppliers through the life of a given drug,” he explains.

But when Gerresheimer floated on the German Stock Exchange last year, it traded at 13-14 times earnings – a valuation appropriate, according to Mr Anniss, to a “boring German glass-maker”, but not to a high-tech company in the lucrative healthcare sector.

Here, then, the inefficiency was brand inertia – investors associated Gerresheimer with something it no longer was. Mr Anniss is hoping to exploit similar misconceptions about I Kloukinas-I Lappas, a small Greek group.

“Historically, Kloukinas-Lappas was a construction company, but, over the last five years, it has invested in retail. It is the only franchisee of Mothercare in Greece and the Balkans, and within the Mother Care division, growth is 30 per cent. Operating margins in retail are 20 per cent, as they have virtually no competition – it’s a very underpenetrated market. They have announced they are selling the construction business, which will leave them with virtually no debt.”

In this case, brand inertia is compounded by an absence of research. “One reason they are completely overlooked is there is only one Greek investment bank that follows the company. It’s a much higher-quality business than the market is giving it credit for,” he says.

Mr Anniss admits, however, it is likely to take the full three to five-year investment term for the group's value to be recognised by the stock-market. “It’s going to be needed on this one,” he observes.

These two stocks share an exposure to healthcare, although neither is strictly in the pharmaceutical industry. Mr Anniss estimates his exposure to healthcare at 11 per cent – far higher than his official sector weighting of 4.6 per cent. Although Mr Anniss’s investment practice is bottom-up, he is interested in the kind of structural growth trends sought by "thematic" investors.

It comes as no surprise, therefore, that his portfolio positioning reflects concerns about the current macro-economic environment.

“I’ve moved out of construction and industrials into defensive areas such as healthcare and food retail,” he notes. He also stresses the fund has been underweight financials for two years. “There will be a time to move back into those sectors, but it’s not yet. We still need to see some earnings downgrades in some areas.”

For Mr Anniss, what sets his fund apart from its rivals is the concentration of the portfolio. “I hold 40-60 stocks, whereas a lot of funds in the sector have 100 or more. In this universe it’s really important to know the companies you’re invested in inside out. Having a long tail is dangerous because, if an investment goes wrong, it can really go badly wrong,” he says.